Ronn Baker

Addressing the challenges of intraday liquidity management

May 2022 in Expert Opinions

By Ronn Baker, Senior Director of North American Sales at Baton Systems

FX is one of the main drivers of liquidity consumption within banks, which must ensure that they always have sufficient liquidity available to meet their cash obligations. Traditionally, unpredictability and lack of data visibility have hampered the efficient funding of nostro accounts. So how can firms best tackle the challenges around managing intraday liquidity?

Nostro accounts and the settlement window

Failure to manage intraday liquidity efficiently has implications not only for individual banks and their customer retention, but also for the market as a whole. But it’s almost impossible for banks to predict at which point during the settlement window inbound funds will be received, so they need to carry large nostro account balances to ensure that their cash obligations can be met, regardless of the point at which their counterparties actually deliver the funds owed.

For a bank to ensure that it is adequately funded – and to report this to the regulators – those balances needs to include various buffers. Lack of data transparency and unpredictability often mean that these buffers get larger and larger. Over-funding often happens as a result of market volatility, so the positions a bank holds are generally way in excess of what they actually need to be. This means that opportunities are missed for redeploying these funds in ways that can benefit and make money for the firm.

Sub-optimal funding is costly in terms of both intraday liquidity usage charges and overdraft fees. Additionally, banks need to be conscious of operational expenses like the costs associated with manual processes.

Some nostro accounts have ceilings and floors in place. Exceeding the balance limit can incur costs if a nostro bank elects to liquidate excess amounts on its terms. On the other hand, maintaining too low a balance can mean that the nostro is forced to close – and nobody wants that. So it’s important for a bank to understand where the ceiling and floor of any given nostro is and to manage balances effectively within that range.

As a result of these factors, banks need the ability to move funds at short notice quickly and safely. When trading emerging markets currencies, for example, this might need to be done outside of core settlement windows to mitigate currency risk.

Implications for the market

On a wider scale, constrained access to funding in heavily-traded currency markets can lead to settlement ‘logjams’ with multiple parties waiting for their counterparties to settle because there’s not sufficient funding available for all settlement obligations to be met at the same time. For the market to function effectively, banks need either sufficient access to liquidity or the ability to settle in smaller shapes in order to accommodate restricted liquidity. The latter solution can introduce a range of operational and control issues that need to be managed.

The benefits of managing intraday liquidity

A 2018 report by Oliver Wyman1 found that banks which are prepared to invest in actively managing and optimising intraday liquidity usage benefit from operational efficiencies and improved profitability.

A bank with faster and better access to funds needs a lower amount of capital reserves to meet customer obligations and satisfy the regulators. By reducing the amount of cash needed to put aside to meet its obligations, a bank reduces the capital it reports and therefore its return on capital improves, with a positive impact on profitability for shareholders.

The study estimated that a typical large bank could have intraday liquidity costs of $100-300M per year, merely reflecting the cost of carry. Putting mechanisms in place where a bank can optimise its use of intraday liquidity, was shown to result in annual cost savings for a typical large bank ranging between $25 and $75M.

What tools does a bank need to manage intraday liquidity better?

My conversations with banks bear out the findings of the Oliver Wyman report – that firms can realise significant value by actively managing intraday liquidity.

To do this, banks need accurate real-time data on their funding sources (i.e. what’s in their nostros) and uses (i.e the firm’s obligations) rather than relying on trust.

This real-time data needs to be combined together with information about inbound payments which the bank is expecting. Some form of predictability (based on historical data, or pre-agreed settlement cycles) is also helpful so that the bank can anticipate cash flows during the course of the day, and respond to variances from these. Finally, banks need the ability to model and optimise the sequencing and strategies deployed to reduce the amplitude of the drawdowns and the use of those funds.Banks can accurately identify the state of their funds using reliable, transparent and normalised data. Processes and workflows can then be automated intelligently off the back of that real-time data. As we know, settlement finality is determined by notification of, and accessibility to, funds. If this is available in real time, funds can be used in the most efficient way for the bank. Delays, on the other hand, mean that the ability to manage those funds effectively is removed.

Baton CORE: liquidity management in real-time

Baton’s Core platform provides a real-time view of a bank’s funds and the ability to report back the debits and credits that affect a given account. The technology can be implemented in a completely customisable manner. It allows for highly configurable and effective netting / agreement processes, including the ability to run these on an intraday basis; better planning on how to react to true needs; and, can be deployed to deliver payment strategies such as splitting and linking. It gives liquidity managers a clear understanding of their needs and more capacity and control for ensuring funds are where they are needed at any point in time. Baton makes distributed workflows available to its customers which allow them to sequence their payments independently in response to the events that are taking place in the course of the day, as well as to their credit risk appetite, funding availability etc. Additionally, they can operate collaboratively with other Baton customers to sequence real time or instantaneous settlement processes at predetermined times. This collaborative process adds an extra element of predictability which helps liquidity managers to plan and respond to events during the course of the day. In short, the ability to manage intraday liquidity more effectively by viewing funding sources and obligations in real time eliminates uncertainty. Combining this with the ability to orchestrate payments intelligently, including the use of collaborative workflows with pre-defined settlement cycles, results in vastly reduced costs, better currency risk management and more efficient use of capital. Firms which don’t take advantage of the tools available to free up their capital reserves may find themselves at a competitive disadvantage as interest rates rise and their costs increase.